By Crispian Balmer
JERUSALEM (Reuters) - The Palestinians' decision to take their bid for statehood to the United Nations has left Israel in a quandary, with no easy moves to counter a diplomatic offensive that could redefine the decades-old Middle East conflict.
Some of Prime Minister Benjamin Netanyahu's ministers want tough retaliation, saying the Palestinian initiative will prevent any meaningful peace talks in future and could provoke fresh unrest in the West Bank after months of relative calm.
Other political leaders recommend caution, arguing that Israel faces enough uncertainty given its worsening ties with Egypt and Turkey, and should ignore the U.N. move as a meaningless public relations exercise.
Netanyahu has not yet decided whether to travel to next week's U.N. General Assembly to defend Israel's corner, underlining the uncertainty at the heart of his government.
"I understand that the Israeli side thinks that this is a bad thing for us. Diagnosis is one thing, but where is the prescription?" said Oded Eran, the head of the Institute for National Security Studies at Tel Aviv University.
"One thing is sure, Israel's image is going to take another beating."
Palestinian President Mahmoud Abbas says he has to take the case to the United Nations because 20 years of U.S.-led talks have hit a dead end, with a deal as elusive as ever.
Israel says it is ready for negotiations, but is refusing to bow to Abbas's pre-condition that it renew its freeze of Jewish settlement building in the occupied West Bank and East Jerusalem -- land that the Palestinians say is theirs.
With Washington set to veto any statehood resolution in the Security Council, the most the Palestinians can expect is a vote in the General Assembly to upgrade their status from an "entity" to a "non-member state" -- a position held by the Vatican.
The United States says the Israeli-Palestinian conflict can be resolved only through direct negotiations.
Netanyahu has toured Europe this year seeking backing for the Israeli stance, and ensure that most major democracies shun the unilateral move that is likely to seek ratification of a Palestinian state on lines held before the 1967 Middle East war.
Some will heed his call, but at least 120 of the 193 U.N. member states look ready to support the Palestinians -- maybe opening the way for them to join other international bodies, including the International Criminal Court (ICC) in the Hague.
Israel fears it could use the ICC to take action against some 500,000 Israelis who live in territory seized in 1967 and whose settlements most world powers regard as illegal.
The prospect of never-ending "lawfare" in the ICC is one of the elements that has most concerned Israeli officials as they calculate the impact of any U.N. upgrade for the Palestinians.
"This dangerous move may deteriorate the situation on the ground, weaken the relatively moderate Palestinians and encourage terror activities," said Strategic Affairs Minister Moshe Yaalon, a Netanyahu deputy and close ally.
Like most Israelis, he says the Palestinian project is a clear violation of the 1993 Oslo Accords which led to the formation of the Palestinian Authority (PA), giving it limited self-rule, and set out the guidelines for future peace talks.
"I'm afraid that eventually ... we and maybe the U.S. and other parties too, shall have to take measures that may have a negative impact on the sustainability of the Palestinian entity," Yaalon told a conference in Herzilya this week.
Some officials suggest the government should withhold tax transfers to the Palestinians as a punishment -- levies Israel collects which make up 70 percent of PA revenues -- or withdraw travel privileges for PA leaders looking to leave the West Bank.
Others propose even more dramatic measures, with Infrastructure Minister Uzi Landau of the nationalist Yisrael Betenu Party demanding that Israel annex its major West Bank settlement blocs in response to any U.N. resolution.
The Israeli military is concerned that settlements could become a focal point of possible Palestinian protests tied to the statehood bid and have offered training to settler security units on how to handle crowd disturbances.
The Palestinians have called for rallies in support of their U.N. action, but have said these will be peaceful, rejecting suggestions another Intifada is in the offing. The Israeli defense minister has also downplayed the prospect of violence.
Around 1,100 Israelis died in Palestinian attacks during the last Intifada from 2000 to 2007. More than 4,500 Palestinians were killed by Israeli forces in the same period.
Rather than counter the Palestinians' current U.N. maneuvers with talk of unrest or reprisals, former Israeli ambassador Alan Baker says, the best thing the government could do is keep quiet and let the storm pass.
"This is just a PR exercise. We should not attach great significance to it," said Baker, who helped draft many of the legal documents that underpin Israel's relations with the PA.
"They are not going to get their borders decided at the U.N. General Assembly," he added, pointing to a declaration of independence by former Palestinian President Yasser Arafat in 1988 that failed to lead to a de facto sovereign state.
"Nothing happened after 1988 because Arafat didn't have the components of statehood. To a certain extent the same is true today. Abu Mazen (Abbas) does not have control of Gaza so cannot herald a state he doesn't hold," Baker said, referring to the small Palestinian enclave run by the rival Islamist group Hamas.
Israel might have tried to defuse the crisis by telling the U.N. that it too supported the notion of a Palestinian state in a resolution that also underscored its own priorities, such as a need for security assurances.
But Netanyahu's advisers rejected this, sticking to the view that such matters can be decided only through negotiations and shrugging off Palestinian complaints that direct talks have achieved very little since the heady days of Oslo.
Ironically, it was the U.N. General Assembly which, in 1947, approved creating a Jewish state in part of then British-ruled Palestine. Arab states were opposed and went to war against the nascent Israel only to lose significant territory.
A Western diplomat in Jerusalem predicted a less dramatic follow up to the latest General Assembly action.
"There is always a lot of sound and fury, but a month after the United Nations General Assembly, the chances are that nothing will have changed on the ground," said the diplomat, who declined to be identified.
(Additional reporting by Dan Williams; Editing by Samia Nakhoul)